To BEAT the market, you cannot BE the market.

To BEAT the market, you cannot BE the market.

Posted by Ryan Irvine

on Monday, 18 September 2017 14:58

Recently we attended an investor conference in Toronto. One of the questions we frequently get at these events is how many stocks one should hold in the growth area of their portfolio. I put together a brief outline of KeyStone’s strategy in this regard. It tends to differ with what many advisors will tell their clients.

Client Strategy – Focused Diversification

I am fond of saying that even if you properly utilize our research methodology and buy just one stock, you are crazy. Even if that stock was our table pounding buy of the year.

On the flip side, you can rigorously apply our methodology and buy 50 stocks and I will tell you are wasting your time. Sounds like we are not sold on our own criteria. This could not be farther from the truth.

In fact, while we are very confident in the long-term success of our research, as part of a portfolio strategy it is incomplete.

For our clients, our strategy does not stop with our research. We advocate an approach we like to call Focused Diversification. The strategy runs counter to what most investors are told by big bank advisors who place them in multiple ETFs or mutual funds, stressing wide diversification. In fact, we have seen many portfolios which hold up to 50 funds. A portfolio composed as such or which holds anything more than a couple well diversified funds is essentially going to leave an investor over diversified, over complicated, paying far too many fees and underperforming the index as a result over time.

For an investor that wants a passive strategy we would recommend investing in a couple of low cost, well diversified ETFs or index funds and calling it a day. This would be far easier to manage and you will incur less fees and either mirror or outperform the fund and ETF laden portfolio.

A portfolio consisting of anything greater than 20-25 individual stocks from an assortment of industry and with a global business reach will provide the average investor with all the diversification needed. In fact, according to modern portfolio theory, there is little benefit of diversification past this number of individual stock investments. With most funds holding over 50 stocks, holding a basket of 10 or 20 funds is diworsification, not effective diversification.   

To beat the market, you cannot be the market.

Our Focused Diversification strategy consists of creating your own fund with 8-12 individual quality stocks in our Canadian Growth Stock Research and 8-12 stocks in our Canadian income stock research. We have also added our US Growth Stock Research which adds depth to the companies in our coverage.

We recommend clients build their 8-12 stock individual growth and income stock portfolios over a 12 to 18-month period – purchasing quality or quantity. Staggering the purchases prevents clients from buying the group of stocks at an annual market high.

You can even start your own growth stock portfolio with our next selection – but make sure this is not the only stock in your Canadian Growth Stock Portfolio!

Sylogist Ltd. (SYX:TSX)

Industry: Technology - Software

Current Price: $8.64

Market Cap: $195,019,388

Shares Outstanding: 22,545,594

Fully Diluted: 24,525,611

Dividend Yield: 3.2%


Sylogist is a software company which, through strategic acquisitions, investments and operations management, provides intellectual property solutions to a wide range of Public Sector customers.  The company publishes mission-critical software products that satisfy the unique and sophisticated functionality requirements of Public Sector entities, non-profit organizations, educational institutions, government agencies as well as public compliance driven and funded businesses.  Sylogist’s comprehensive suite of software solutions to manage their financial, human resources and operational requirements. Solutions are delivered as customer installed or cloud based Software-as-a-Service (SaaS).


We expected 2017 to be a transitional year for Sylogist and one in which the company would be hard pressed to post organic growth (although this can change quickly with one or two significant signings – depending on the type of license taken). This has indeed been the case. Year-over-year the company’s quarterly results have been lower after 5-year of tremendous revenue growth that saw the company growth sales from $9.2 million in 2012 to $35.85 million in 2016. Over the same period, EBITDA grew from $3.96 million in 2012 to $13.57 million in 2016.

While we expect the company to be hard pressed to post revenue and cash flow growth in 2017, the trend is in the right direction. Year-to-date, quarterly revenues have shown sequential growth from $7.83 million in Q1, to $8.13 million in Q2, and $8.92 million in Q3 with an improving bottom line.

During 2016, Sylogist also made significant, foundational capital investments focused on additional infrastructure capacity to facilitate potentially rapid growth, including the centralization its internally hosted systems and the implementation of a new ERP/CRM system. Consistent with its Public Sector focus and to improve financial returns, the company signed an agreement with Microsoft on August 2, 2016 which significantly lowers the company’s Microsoft royalty rates going forward into fiscal 2017 and beyond. Sylogist is now investing in, and expanding its offerings in the K-12 education and local government markets internationally, with particular emphasis on the US market. We believe this investment and the cost savings initiatives in 2016-2017 will facilitate a return to organic revenue and cash flow growth in 2018.


Management appears to be executing on the cost front as the company’s third quarter cost of sales was $2.4 million, or 27 per cent, of revenues compared to $3.1 million, or 32 per cent, of revenues for the comparative period ended June 30, 2016.

While operating expenses and G&A costs are down in 2017, it is important to note that research and development for new and existing products and sales and marketing spending are up. Overall costs are down, but spending in the areas that can create growth, are up.  This is a formula we like to see.

Sylogist intends to continue to grow its business through strategic acquisitions, or investments to expand its existing Public Sector business. This will continue to be a focus as the company looks to extend its reach. Sylogist continues to review and engage potential acquisition prospects that meet its selected acquisition criteria. With approximately $30 million, or 17%, of its market-cap in cash and no debt, the company is well positioned to make further acquisitions without diluting existing shareholders.

Microsoft Agreement

A great deal of Sylogists growth in 2016 was due to the strength of the company’s performance in the Public Sector non-profit and non-governmental organization markets. The success was driven by Sylogist being awarded several significant contracts with some of the world’s most notable charitable organizations. These larger, multi-phased contracts translate into more recurring revenues for the company.

Consistent with Sylogist’s Public Sector focus and to improve financial returns, the company signed an agreement with Microsoft on August 2, 2016, which significantly lowers the company’s Microsoft  royalty rates going forward into fiscal 2017 and beyond. With this agreement, Sylogist is also able to expand the reach of its Public Sector products, providing a broad, mid-market Public Sector SaaS offering, with the brand value of Microsoft at the core.

The major opportunity in the United States and Canada is for the large base of public sector organizations suffering with multi-vendor legacy systems. Sylogist will now be able to offer this large group a comprehensive solution, fully integrated with their other Microsoft products, operating in the secure Microsoft  Azure cloud or on-premises of the customers’ choosing. Sylogist will continue to support and enhance its current public sector financial solutions in Canada.  The integration of the Microsoft Dynamics NAV based financial solution, via Serenic Navigator, with the Bellamy analytics, budgeting, asset management, revenue and operating modules, provides a compelling offering to new customers and an attractive future migration option for Sylogists current customers.



Sylogist’s trailing (last 12 months) adjusted earnings are $0.48 per share. In its current range the stock trades at 17.92 times earnings which is slightly below the market average and well below its peer group.  The company’s trailing Adjusted EBITDA is $13.75 million. Enterprise Value to Adjusted EBITDA multiple over the past 12 months is relatively low at 11.90 and at a discount to peer traditional software and SAAS firms. We estimate the company could report earnings in the range of $0.61 per share over the next 12-months, dependent on the US/CAD movement. A stronger US$ is more favorable as the majority of revenues are booked in US$. The earnings estimate would be based on continued cost efficiencies, lower royalty rates with Microsoft and a return to growth. The estimate does not factor in any acquisitions. A market equivalent multiple of 18 times our expected adjusted earnings over the next 12 months would produce a fair value in the range of $12.15 (comprised of 18*$0.61 + $1.33 in cash) or 40 percent higher than the current range. The stock also pays a $0.07 quarterly dividend for a yield of 3.3 per cent which we see as sustainable.


We viewed 2017 as a transitional year that, as investors, we entered with caution in regards to Sylogist. Management appears to be aligned to a large degree with shareholders and has delivered on most of its limited “guidance” from its quarterly results including the cost reductions which have produced improved profitability over the course of 2017. 

We believe the company is on pace to return to revenue growth in Q4 which should also be accompanied by growth in the bottom line, year-over-year.  The caveat here is the exchange rate which could throw a curve-ball into the numbers. Long term, we do not see this as a significant issue.

Based on the $35.6 million trailing twelve-month revenue run rate at Q1 2017, the annual net positive cash impact of the organizational changes including cost rationalization and the new Microsoft agreement is expected to be approximately $4 million in fiscal 2017 and $6 million in fiscal 2018, when the full benefits of the changes are realized. Some of these savings will be reinvested in organic growth initiatives in product development and marketing for fiscal 2017 in order to lay the foundation for 2018 organic revenue performance. If the uptick in revenues, particularly recurring revenues, continues into Q4 2017 and 2018 as management expects, the current price appears to be a good entry point for investors looking 1-3 years forward – particularly ahead of a potential return to annual revenue growth in 2018.

We estimate the company could report earnings in the range of $0.61 per share over the next 12 months, dependent on the US/CAD movement.  e earnings estimate would be based on continued cost efficiencies, lower royalty rates with Microsoft and a return to growth. The estimate does not factor in any acquisitions. A market equivalent multiple of 18 times our expected adjusted earnings over the next 12 months would produce a fair value in the range of $12.15 (comprised of 18*$0.61 + $1.33 in cash) or 40% higher than the current range.  The stock also pays a $0.07 quarterly dividend for a yield of 3.3% which we see as sustainable.

We reiterate our BUY rating on the stock. The shares are relatively illiquid and we recommend investors use limit orders in the $8.50-$9.50 range. Be patient and positions should be filled over the next 1-2 months. We do not see a hurry to rush in and bid up the stock.

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